Employer class and the employee’s regime determine the percentage
For tax year 2026–27, section 124(1) of the Income-tax Act, 2025 allows an individual employee a deduction for an employer contribution to the notified pension scheme, capped at 14% of salary where the employer is the Central or a State Government and 10% for other employers. Section 124(2) substitutes 14% for the other-employer 10% limit where the employee’s total income is taxed under section 202(1). Actual qualifying employer contribution remains the starting amount; an unused percentage ceiling is not a notional deduction.
This working uses the Income-tax Act, 2025 as amended by Finance Act, 2026: sections 7, 17, 29, 124 and 202, effective from 1 April 2026. It concerns the employer-funded pension contribution, commonly encountered in corporate NPS payroll. Older references to section 80CCD(2) belong to the earlier Act; use the law governing the earning period. The article does not calculate pension withdrawals or the employee’s separate personal-contribution relief.
| Employer / employee position | Percentage ceiling | Deduction amount |
|---|---|---|
| Central or State Government employer | 14% of qualifying salary | Lower of qualifying employer contribution and the ceiling. |
| Other employer; employee taxed under section 202(1) | 14% of qualifying salary | Apply section 124(2), not the unmodified 10% figure. |
| Other employer; employee outside section 202(1) | 10% of qualifying salary | Do not import the employer’s own business-deduction rate. |
Reconcile the salary base rather than using CTC
Section 124(13)(b) includes dearness allowance where the employment terms so provide, but excludes other allowances and perquisites. Build the base from salary components, separating HRA, other allowances, benefits and employer pension funding. The contribution itself should not be added to the percentage base merely because payroll reports it as part of the overall package.
For an employee working only part of the year, use the salary of the relevant tax year supported by actual service and payroll records. An annualised headline package is not proof of salary earned for twelve months. Where components change during the year, reconcile the periods and year-end totals rather than multiplying only the last month’s figure by twelve.
Inclusion and deduction are separate entries
Section 7(1)(c) deems the employer pension contribution received in the relevant year. Do not omit the employer contribution from the income-side reconciliation and then also claim a deduction, which would create a double benefit. Trace the salary reporting to the pension-account contribution evidence and then apply section 124. A proposed contribution, a payroll provision and a completed qualifying contribution are not interchangeable evidence.
The employee’s own pension contribution has separate provisions, including section 124(3), and cannot be relabelled as employer funding simply because the employer remits both through one transaction. Section 202(2)(a)(xii) preserves sections 124(1) and (2) while excluding most Chapter VIII deductions. This employer deduction is therefore available under the new regime within its conditions; that does not make personal pension contributions deductible under the same route.
The employer’s 14% business limit does not fix the employee’s deduction
Section 29(1)(b) separately addresses the employer’s business deduction for sums paid towards the pension scheme, up to 14% of the employee’s defined salary. That is a different taxpayer and computation. A private employer paying 14% does not, by that fact alone, give an old-regime employee a 14% deduction. Payment and other applicable employer-side conditions still need their own assessment.
Run the aggregate contribution-perquisite check independently
Section 17(1)(h) treats the aggregate employer contribution exceeding ₹7,50,000 in the tax year to a recognised provident fund, the section 124(1) scheme and an approved superannuation fund as a perquisite. Section 17(1)(i) separately deals with prescribed annual accretion attributable to that excess. The pension percentage calculation does not replace this aggregate check, and the ₹7.5 lakh figure is not itself a substitute ceiling in section 124.
Keep an employer-funded retirement-benefit schedule by fund, distinguishing each contribution and any separate annual-accretion calculation. The examples below show contribution and deduction workings, not final slab tax, surcharge or cess. The aggregate-perquisite illustration isolates the contribution excess and does not assume that the annual-accretion amount is nil.
Worked illustrations
These illustrations use fictional facts and expressly stated assumptions. Amounts are Indian rupees unless a different currency or unit is specified. They are independent examples, not findings about any actual client.
Illustrative example 1: Private employer, employee outside the new regime
Qualifying annual salary is ₹12,00,000 and actual employer pension contribution ₹1,68,000. The employee is not taxed under section 202(1). Ceiling = 10% × ₹12,00,000 = ₹1,20,000; deduction = ₹1,20,000. Of the employer contribution, ₹48,000 is not covered by this deduction. This is a deduction shortfall, not a separate calculation of the aggregate-contribution perquisite.
Illustrative example 2: Same contribution under section 202(1)
Use the same ₹12,00,000 salary and ₹1,68,000 contribution, but the employee is taxed under section 202(1). Ceiling = 14% × ₹12,00,000 = ₹1,68,000. The whole ₹1,68,000 is deductible, ₹48,000 more than in the previous alternative. This difference alone does not decide which regime gives the lower overall tax.
Illustrative example 3: State Government employer outside section 202(1)
A State Government employee has qualifying salary ₹15,00,000 and actual qualifying employer contribution ₹2,40,000. Section 124(1)(a) gives a 14% ceiling regardless of the other-employer substitution: ₹2,10,000. Deduction = ₹2,10,000; ₹30,000 of the contribution is outside this deduction. Do not apply the 10% private-employer old-regime limit here.
Illustrative example 4: Remove other allowances from the base
Annual basic salary is ₹12,00,000, qualifying DA ₹1,20,000 and other allowances ₹2,40,000. Qualifying salary = ₹13,20,000, not ₹15,60,000. For a private employer contribution of ₹2,10,000 and an employee under section 202(1), the ceiling is ₹1,84,800. Deduction is ₹1,84,800, leaving ₹25,200 uncovered. Using all allowances would incorrectly produce a ₹2,18,400 ceiling.
Illustrative example 5: Part-year employment does not create a twelve-month base
An employee works six months at monthly basic ₹80,000 plus qualifying DA ₹20,000, with no salary from this employer in the other months. Relevant salary = 6 × ₹1,00,000 = ₹6,00,000. Actual employer contribution is ₹96,000. Under section 202(1), ceiling = ₹84,000; deduction = ₹84,000 and uncovered contribution ₹12,000. Doubling the salary to a hypothetical full-year package would overstate the deduction.
Illustrative example 6: Actual funding is below the available ceiling
A private-company employee under section 202(1) has qualifying salary ₹18,00,000, but actual employer pension contribution is ₹90,000. The percentage ceiling is ₹2,52,000; deduction is only ₹90,000. The unused ₹1,62,000 of ceiling is neither an extra deduction nor, by itself, a carry-forward claim.
Illustrative example 7: The pension deduction and contribution perquisite can coexist
An employee under section 202(1) has qualifying salary ₹60,00,000 and employer pension contribution ₹8,40,000. The section 124 ceiling is ₹8,40,000. The employer also contributes ₹3,60,000 to a recognised provident fund and nothing to an approved superannuation fund. Aggregate covered employer contributions = ₹12,00,000. Contribution excess under section 17(1)(h) = ₹12,00,000 − ₹7,50,000 = ₹4,50,000. Assess that perquisite separately from the ₹8,40,000 pension deduction; any attributable annual accretion requires its own calculation.
Ten-step verification table
| Step | Verification | Evidence to retain |
|---|---|---|
| 1 | Identify the tax year and law version. | Tax-year payroll and applicable Act. |
| 2 | Classify the actual employer. | Central/State Government status or other-employer evidence. |
| 3 | Confirm the employee’s regime for the computation. | Regime decision and payroll/return reconciliation. |
| 4 | Reconstruct qualifying salary component by component. | Basic, qualifying DA and excluded-benefit schedule. |
| 5 | Use the actual service period and annual salary. | Joining/leaving dates and period payroll. |
| 6 | Separate employer from personal contributions. | Pension statement and funding-source reconciliation. |
| 7 | Reconcile income inclusion and actual contribution. | Section 7/salary reporting and remittance records. |
| 8 | Apply the correct percentage and actual-amount ceiling. | Section 124 computation. |
| 9 | Aggregate employer-funded PF, pension and superannuation. | Section 17(1)(h) and separate accretion review. |
| 10 | Reconcile employee and employer tax workings separately. | Employee deduction, employer payment deduction and final payroll file. |
Sixteen practitioner FAQs
1. Is every employee entitled to 14%?
No. For other employers, the employee’s section 202(1) position determines whether section 124(2) replaces 10% with 14%.
2. What rate applies to Central or State Government contributions?
Section 124(1)(a) specifies 14% of qualifying salary.
3. Is a government-owned company necessarily the Government employer?
Do not infer that merely from ownership. Establish the legal employer’s classification for section 124.
4. Is the limit based on cost to company?
No. Reconcile the section’s salary definition, including qualifying DA and excluding other allowances and perquisites.
5. Is HRA added to the percentage base?
It is an allowance excluded from this salary base; do not use gross package totals indiscriminately.
6. Can a mid-year joiner use twelve months of the quoted monthly salary?
Not without that salary actually forming the relevant tax-year base. Use supported salary and service-period records.
7. Does the contribution enter the income reconciliation?
Yes. Section 7(1)(c) addresses deemed receipt; show the appropriate income inclusion and then the permitted deduction.
8. Can the employee claim the ceiling if the employer paid less?
No. The deduction cannot exceed the actual qualifying employer contribution.
9. Can unused percentage headroom be carried forward automatically?
No such carry-forward arises merely from unused section 124 percentage headroom.
10. Can employee funding be put in the employer column?
No. Identify the real funding source even when the payroll remittance combines both components.
11. Is employer pension relief part of the section 123 ₹1.5 lakh basket?
Section 124(1) is a separate employer-contribution deduction with its own percentage test; do not consume it inside the section 123 basket.
12. Does the new regime preserve the personal ₹50,000 pension deduction too?
Section 202 preserves sections 124(1) and (2), not a general personal-contribution claim under section 124(3).
13. Why can the employer deduct 14% while an employee can deduct only 10%?
Section 29 and section 124 govern different taxpayers. The employer’s business limit does not override the employee’s regime-specific limit.
14. Does ₹7.5 lakh replace the pension percentage cap?
No. It is a separate aggregate employer-contribution perquisite test involving the specified funds.
15. Can a pension contribution within 14% still require a perquisite review?
Yes. Aggregate contributions to the three covered categories can exceed ₹7.5 lakh even where the pension contribution fits its percentage ceiling.
16. Do the examples show final tax payable?
No. They isolate deductions and the stated contribution-perquisite base. Final salary tax and any prescribed accretion calculation are separate.
Working-paper organisation
Keep the source documents, calculation and final conclusion together for the same entity and period. If using assureTax or other assureOffice tools, use only confirmed available functions and retain this evidence with the output.
Conclusion
Use one salary reconciliation but separate the employee’s deduction, the employer’s business deduction and the contribution-perquisite review. The correct 10%/14% result is only one part of the complete retirement-benefit tax computation.